jrootham.ca

Economics of Private Landlords

Summary and Recommendations

Private landlords are a bad idea because markets will only drive rent down to the costs of new construction, not the (much lower) costs of existing buildings.

This not only directly causes affordability issues but also creates a very large wealth transfer from renters to landlords.

The solution to this problem is enough non profit housing to remove the market power of private landlords. This housing does not need to be subsidized, it just needs to charge only enough to cover its costs. It does not matter if the housing is owned directly by the government, is a not for profit co-op, or is owned by a not for profit organization.

Exactly how this gets implemented is beyond the scope of this paper. Given that there are multiple possible solutions, there will be multiple future papers exploring the options.

About Jim Rootham

Jim Rootham has been the chair of the finance committee of his co-op for most of the last 40 years. He is a computer programmer by trade. He spent some time in the financial industry, where he learned about financial instruments. He is mostly self taught in Political Economy.

Economics

Introduction

This paper decribes a high level model of cost and rents for rental buildings. It only deals with buildings with relatively high attractiveness (near median rents and above), since those are the ones with policy salience.

A fundamental assumption is that building life is measured in decades or centuries.

Costs

The absolute value of the costs specified below are very loose estimates. The key point in the analysis is how they change over time.

The cost structure for rental buildings has three categories: Mortgage; Operating; Replacement Reserves.

Mortgage

I do not know of any generally accepted long term model for interest rates.

The model used here assumes that the Bank of Canada hits its target rate for inflation and interest rates are therefore constant. This is clearly false in the short term, but is a reasonable long term assumption.

The mortgage costs assume a total capital cost of $400,000 with an 85% mortgage (15% down payment) at 6% interest with a 25 year amortization period.

Operating

Operating costs include taxes, utilities, employees, maintenance, and others. The simplifying assumption here is to estimate the costs at startup and have them increase by inflation every year. As with the mortgage model the assumption assumes that the Bank of Canada hits its inflation rate target (2%).

The operating costs are derived from the experience of my co-op.

Replacement Reserves

Replacement reserves are money saved to pay for large maintenance items. To estimate them properly requires a building condtion assessment to determine the timing of the replacement and a financial plan to determine the saving rate.

The simplified plan here starts with an estimate and inflates it every year by the expected inflation for large repairs, which at 3.5% is higher than the assumed 2% general inflation rate.

The 3.5% is from the current replacement reserve study for my co-op. The starting value is an estimate.

Total Costs

The sum of the three categories.

Profitability

Location, location, location also applies to rentals, so we have desirable locations and undesirable locations.

In this analysis we assume desirable locations and profit maximization on the part of the owners. This is what Econ 101 claims is the wonderful solution. Older buildings are massively profitable.

Given that future profits can be much higher than current profits it may involve flipping properties. In this case current profits may be relatively low because they have already been captured by the price paid for the building.

Rents

In the charts below the rent estimates (start just below costs and increase by the inflation rate) are very conservative.

Profits

The profits are the rents minus the total costs.

Charts

The charts are about cash flow, they do not include more complex calculations of profit and loss.

Graph of nominal dollar flows

The nominal dollar chart is best interpreted as the history of a typical rental project.

Graph of constant dollar flows

The constant dollar chart is best interpreted as the typical cash flow this year of a unit built that many years ago.

Discussion

The most obvious point about how costs change over time is the drop in coste when the mortgage is paid off.

The other notable point is how replacement reserves gradually dominate costs.

On the income side it is notable how big the profits get.

Conclusions

There are several things we can see from this analysis.

1. Over the (long) life of a project the initial capital costs are almost irrelevant.

2. Large scale maintenance costs eventually dominate the cost structure.

3. Over a long enough timescale rental properties accumulated profits are astoundingly large.